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10 Reasons to Rollover Your 401(k) into an IRA

Many people gloss over the question of what to do with an old retirement plan - chances are, you’re changing jobs and busy signing the employment contract, filling out paperwork, and counting up your vacation days. Or, you might be retiring and dreaming of your new and more relaxed retirement lifestyle

But it’s important to think about what happens to your old 401(k) when you get a new job, retire, or leave a company to start your own business. What you do with your employer-sponsored retirement plan could affect your taxes, costing you money that would have otherwise gone into your retirement savings - so choose wisely. 

What Happens to Your 401(k) When You Leave a Job?

When you change jobs or retire, you generally have a few options for any retirement plan(s) you had with the old employer: 

Option 1: Leave Your Money Where it Is 

If your 401(k) has more than $5,000 in it, most employers will allow you to keep your money in their retirement plan after you leave. This option may seem easiest since it requires no action, but it can be easy to forget about old accounts, especially if you change jobs often. 

Option 2: Roll it Into Your New Employer’s 401(k) 

If you’re changing jobs and your new employer offers a 401(k), it’s possible to roll over your old account into the new one. The simplest way to do this without paying any taxes is a direct or "trustee-to-trustee," rollover. Just ask your employer or plan administrator to make the payment directly to the new plan. 

Indirect rollovers are more complicated. They give you the chance to use the money for 60 days before reinvesting - but it’ll cost you 20% in taxes upfront, which you’ll have to make up before reinvesing if you want to recoup the tax break. Talk to your financial advisor, or make sure you thoroughly understand all the rules before going this route.

Option 3: Rollover to an IRA 

If you’re retiring, starting your own business, or your new employer doesn’t offer a retirement plan (or you don’t like their option), you can roll your old 401(k) into an IRA. We recommend this option because it allows you to keep growing your retirement savings with tax breaks and other advantages (which we’ll cover below).

Option 4: Take a Cash Payment  

Technically, you can cash out your entire 401(k) account and gain access to the funds. We don’t recommend this, though, as the entire amount will count as taxable income. Plus, you’ll have to pay a 10% early withdrawal penalty if you’re under age 59 ½. 

If the balance of your 401(k) is under $1,000 when you leave a job, your employer may close it out automatically - you’ll get a check minus 20% for taxes. If you do take a cash payment, we recommend redepositing it immediately into another retirement plan or your emergency fund.

10 Reasons to Roll Over Your 401(K) to an IRA

Depending on your circumstances, it’s often in your best interest to rollover your 401(k) to an IRA. Here are 10 reasons we recommend rolling over your 401(k) to an IRA versus simply leaving it with your old employer - especially if you’re retiring: 

  1. Flexibility -  IRAs tend to have fewer rules than 401(k)s, you have access to more investment options, and you can often rebalance without restrictions.
  2. Control - As the account owner (not just a participant) you have more control over what happens to your accounts. This can include: what funds to invest in, when and how you take distributions, as well as allowing for “in-time” planning opportunities.
  3. Tax benefits - When done correctly, your money keeps growing tax-deferred and you won’t have to pay any penalties.
  4. Consolidation - Rather than having a 401(k) for every company you worked for, rolling over to an IRA lets you combine funds into fewer accounts. That way, you or your heirs aren’t left chasing after old retirement accounts. This also ensures your investment philosophy is an alignment with your financial plan as you will only have to manage one allocation vs. multiple across different platforms
  5. The Roth option - Roth conversions give you the ability to balance your asset mix and achieve tax savings. Some 401(k) providers do not allow you to open a Roth account and thus limits your ability to make “in-time” conversions which can have a big impact on your retirement goals. 
  6. Continued contributions - You can’t keep contributing to an old employer’s 401(k)s once you’ve left a job, but you can add funds to your IRA for as long as you’d like.
  7. Simplifies required minimum distributions - An IRA keeps things simpler when you start taking required minimum distributions (RMDs). If you have a 401(k) and IRA, you have to take a separate RMD from each account. If you have two IRAs, you can take the total RMD amount from one account. 
  8. Estate planning advantages - Many 401(k) plans require beneficiaries to take a lump-sum payment, but IRAs have more inheritance options. 
  9. Lower cost - Administrative and management costs for most types of IRAs tend to be much lower than 401(k)s, which often come with hidden fees
  10. No blackout periods - 401(k)s experience regular blackout periods during which you can’t access your accounts. Blackouts can last up to ten days to allow for plan changes.

If you’re unsure which option is best for you, you always have the option of speaking to a financial advisor. They can help you weigh your options, calculate the potential tax consequences, and also guide you through the rollover process. Whether you need advice on a specific topic or a comprehensive financial plan, a financial advisor, such as a Certified Financial Planner, will point you in the right direction. 

More importantly, the right financial advisor will help you assess your financial big picture including your: 

  • Current assets & income sources
  • Spending & budget
  • Financial goals for the future
  • Retirement lifestyle goals
  • Retirement target age

Need a solid game plan for your next stage in life? Our free 2021 Essential Retirement Guide helps you identify potential gaps and build your roadmap to a successful retirement. 

Essential retirement guide 2022


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